Fundamental Indexation: Rebalancing Assumptions and Performance
We show that the performance of a fundamental index with annual rebalancing, as proposed by Arnott, Hsu and Moore (2005), can be highly sensitive to the subjective choice of when to rebalance. Although performance differences between fundamental indexes rebalanced at different dates tend to be small in the long run, they can be substantial at shorter horizons. For the year 2009, for example, we find that a fundamental index rebalanced every March outperformed the capitalization-weighted index by over 10%, whereas a fundamental index rebalanced every September underperformed. This performance ambiguity is an undesirable feature for an index which is used for benchmarking purposes. We introduce the idea of blending multiple underlying fundamental indexes, each one rebalanced annually, but at different dates, as an example of how to construct a more robust fundamental index without increasing turnover.
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